<THE FOOLISH FOUR>
Why?
by Bob Price
([email protected])
Houston, TX (November 10, 1998) -- If you've had small children, you're familiar with the question. It's good for adults to ask "why" from time to time, too. Let's "why" our way through some basic topics.
Why invest in stocks?
Stocks have outperformed every other investment class over the long term. Every comparative study has confirmed that over long time periods (20 years), quality US company stocks always outperform bonds and bank accounts. The basic reference on this is Stocks for the Long Run. Follow that hyperlink and you can read more about it. Let me emphasize one point. The argument in that book is based on achieving average market returns (what your typical index fund can do). You might call this "market performance."
Why invest in Dow stocks?
Over the long run, the Dow stocks have performed essentially the same as the Standard & Poor's 500 Index, and to many people their performance is "the market." Until the invention of index-tracking mutual funds, buying all 30 Dow stocks was the cheapest way to get "market performance."
Why invest in the Dow stocks instead of an index fund?
Johnny, go out and play! Seriously, since January, Dow Diamonds <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: DIA)") else Response.Write("(AMEX: DIA)") end if %> have been available on the American stock exchange. Buy DIA and get a bit of all Dow stocks in one security with very low expenses. But the real answer is this: We think we can do better than an index fund, that's why.
How can you do better?
A look at the returns of the Dow 30 leads to the following brilliant observation: Not all the stocks have the same returns. Some go up, by greater or lesser amounts, and some go down. If you can select stocks from the Dow 30 that are likely to go up a lot, or at least not likely to go down, you can improve your returns.
Well, duh! But how?
The big-money question! You need to find some factor or factors that will predict whether the stock will go up or down. A real simple-minded approach turns out to work well. A quick look at the Dow stocks reveals that most pay dividends most of the time. Simply ranking the stocks by dividend yield turns out to be an effective Dow stock selection system. We call the top 10 yielders of the Dow the "HY10." As you can see by studying the chart at the bottom of last Friday's column, they have outperformed the S&P 500 (and the Dow 30, therefore) handsomely over time.
Why "handsomely?" It only beat the S&P 500 by about 3%
Because "only" isn't the appropriate word to use there. Over 37 years, those 3 percentage points make a difference of 2.7 times in your money -- you'd have nearly 3 times more money with the higher rate. But, of course, we didn't stop there.
Why?
Why not? We always want to do better. For instance, as last Friday's column also indicated, the Foolish Four, and especially the RP approach (which you can read about here), have done much better. You would have over 11 times the money with RP over 37 years that you would have with the Dow as a whole over 37 years.
Will the next 37 years be the same? Who knows, but the odds are high that these strategies will continue to outperform.
Coming up: Some new Dow systems (at least, new to most readers).
Fool on!
Current Dow Order | 1998 Dow Returns
11/10/98 Close
Stock Change Last -------------------- UK -2 1/8 43.50 IP + 3/16 45.94 MO +1 1/16 54.13 EK - 5/8 78.56 |
Day Month Year
FOOL-4 -0.69% 4.25% 15.62%
DJIA -0.38% 3.16% 12.09%
S&P 500 -0.17% 2.69% 16.26%
NASDAQ +0.25% 5.32% 18.80%
Rec'd # Security In At Now Change
12/31/97 206 Eastman Ko 60.56 78.56 29.72%
12/31/97 276 Philip Mor 45.25 54.13 19.61%
12/31/97 289 Int'l Pape 43.13 45.94 6.52%
12/31/97 291 Union Carb 42.94 43.50 1.31%
Rec'd # Security In At Value Change
12/31/97 206 Eastman Ko 12475.88 16183.88 $3708.00
12/31/97 276 Philip Mor 12489.00 14938.50 $2449.50
12/31/97 289 Int'l Pape 12463.13 13275.94 $812.81
12/31/97 291 Union Carb 12494.81 12658.50 $163.69
CASH $754.73
TOTAL $57811.54
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